Private Incentives to Innovate: Interplay of New Products and Brand-Name Reputation

The automobile industry is one of the most innovative sectors in the economy and has become also very competitive in spite of its oligopolistic market structure. Besides, the triad traditional automotive markets (Japan, USA, and Western Europe) are very satiated markets. Thus, there should be some market power enjoyed by the automobile manufacturers to be able to pay for costly (and often risky) innovations and new products introductions. This paper concentrates on studying the introduction of new products in the automobile industry, in particular, on the measurement of the private returns to innovations for automobile manufacturers. The focus is on the two sources of market power that may allow the firms to get higher profits (and, thus, recoup investments): new products and brand-name reputation. On the one hand, margins can be secured temporarily through the launch of new products and the creation of new market niches due to less pricing pressure. This can yield profits to the innovators and allow them to recoup their investments, and may also bring gains to the consumers. On the other hand, the margins can be secured rather permanently through the establishment of strong brands. This generates larger cash flows, which leads to more investment being undertaken by the premium and luxury car manufacturers. The objective of this paper is thus to look whether there is a reward for innovation in the automobile market. The incentives to innovate are studied for the German automobile market, which is characterized by a high degree of new product introductions to boost sales and a large role of brand-name reputation, being also a lead market for many innovations. The results of the study show a new model and brand-name reputation appear to allow the innovative firms to get some market power and recoup their investments. New products however do not constitute a separate market niche but compete with old models.

Leheyda, Nina (2008), Private Incentives to Innovate: Interplay of New Products and Brand-Name Reputation, ZEW Discussion Paper No. 08-120, Mannheim.